Is the Digital Yuan ready to take on the Dollar as a reserve currency?

China’s upcoming launch of its new digital currency (the digital Yuan) is seen as its latest tool to achieve supremacy on international commerce. Dissecting the information brings the few key insights:

This is essentially a political issue

First, the digital currency will be directly managed by the Chinese Central Bank which will help increasing China’s already strong hold on its privacy control policies via a monitoring of consumers’ spending habits.

Secondly, China and the US are on battle to economic supremacy. In that way, China welcomes the publicity created around this announcement, particularly as a possible threat to the US Dollar dominance; whether factual or not.

This is obviously a tech issue

This new currency will inevitably bring about a boost in innovation. While tech companies will be on the front line, other multinational companies are likely to profit as well if it proves to be a more convenient settlement form. However, since China does not have a monopoly of this technology, it will very likely be caught up by others if tangible additional benefit to the general public can be demonstrated.

Who will be the losers here?

Analysis so far suggests that in its efforts to have a stronger hold of its consumers spending, China will very likely cut the middle man of the current monetary system i.e. the banks.

Whether it is to attempt reducing a rampant and fairly uncontrollable shadow banking debt burden its home ground or to move closer to a cashless economy (for sanitary reasons or to reduce the costs of imports and international payments), this innovation will affect the banking industry as it is known today.

Banks are already attempting to weather today’s fintech storm by adapting their technologies and offerings. While they will certainly fight back and adapt to the innovation, the banking system as we know it today is irreversibly changing towards a more tech integrated format with less human interaction. As pointed in a previous post, the role of advisor might be the only sustainable service for the Banking industry in the long run.

What about Africa?

Africa won’t be foreign to this trend. The continent has been known to effect giant leaps into innovation sometimes without following rest of the world’s evolution patterns. This is partly due to the fact that it’s buoyant and constantly growing market is seen as fertile ground to test new technologies and their scalability. Therefore, provided technological or infrastructure tweaks can be operated, Africa is always presented with an adaptation of new technologies and more often than not it manages to acclimate fast enough to considerably embrace the innovation.

So, can the digital Yuan achieve market supremacy?

Assertively answering that question is a serious gamble today. Just as no one knew what a smartphone was a decade ago, no one knows for sure what the future holds in the tech world. That being said, monetary dominance has more to do with Economics than it has with technological advancement. Let’s make a parallel analysis.

The United States:

Key elements that makes a currency a dominant one are: the fact that it belongs to a major commercial hub, which leads (amongst other) to the currency being used by a larger number of consumers to settle financial transactions and the fact that it is represents a safe value against depreciation, which leads to a number of economies adopting the currency as transactional tool when the local currency fails to fill this role.

America has been the world’s most productive area for the past 130 years.

The U.S. took over as a main transactional hub of the world in the late 19 century following a century of British domination created by the invention of the steam engine. From 1890, the American east coast and the Boston took over as a main commercial hub following the set-up of industrialized explosive engine automotive. Following the 1929 depression, New York was at the heart of the American (and the world’s) post-depression recovery buoyed by the invention and expansion of electricity. The 1980’s saw the emergence of the west coast’s incredible technological innovation wave with the internet, its dot.com boom and the rise of the mighty Silicon Valley.

As if the export of its production over the century was not enough, America has never hesitated to print money to fund its various monetary needs including its everlasting deficit. This important quantity of dollars in circulation therefore found its way into the “pockets” of the many parties who very much needed it to transact with “America Inc.”. This includes foreign governments (one of the most prominent one being China), purchasers of America’s debt and holding U.S Dollars as a form of “collateral”.

The Dollar is also vastly used as a safeguard against local depreciating currencies. The DRC is an example of this. The DRC economy does not count the United States amongst its top export trading partners and most of its imports come from the Euro zone and China. However, it is one of the largest dollarized market on the continent for many years.

China needs to work at filling the above mentioned characteristics for the Yuan to start looking at taking over form the US Dollars major world currency status.

China:

China has the potential to be world’s ext transactional hub. The productivity the Chinese economy has accomplished over the past two decade has been nothing short of phenomenal. Key elements of that productivity includes vast Government spending and an immense local fueling consumption and spending.

However China still has many challenges to overcome before it claims the major transactional hub status, that US, the UK or other the Dutch empire claimed before them.

Despite the attractiveness of its internal market, Government’s involvement in business dealings remains a major drawback for a number of investments in China. The communist party is actually present within businesses depending on the size. This clearly hampers private initiative[i].

Skills remain limited. Because it has been labelled the manufacturing hub of the world, China appears to have plenty of skilled workers available. An in-depth look shows major gaps in that regard. For example, in 2005, 600,000 engineers graduated from Chinese universities. However, a report from the McKinsey Global Institute estimated that only one in ten were ready to work at a foreign multinational.[ii] China is currently struggling with a large gap of skilled labor badly needed by its growing economy.

China’s still has a large amount of underdeveloped rural areas that growth hasn’t reached yet. While those areas are expected to catch up in the next two decades, its population is fairly unproductive owing to its skillset and age. China’s longstanding one child policy made it so that if the limited currently employable population is not rapidly educated to cater for the country’s current and future needs, they will only be useful as low skill labor. The gap thus created will take another decade to be filled.

China’s is struggling with innovation. A lot of what is seen as vibrant development of Chinese based ideas are in fact existing technologies adapted to Chinese market rules. That catch up exercise requires so much work that actual innovation is somehow left to the side. Another factor of the limited innovation has to do with the educational system that is not designed to encourage creativity. Universities are the cradle of innovative forces. But institutions can hardly provide a fertile ground for creativity when directly managed by Government’s restrictive supervision[iii].

China has many arguments showing it is coming up as a major economic force. That being said, the digital Yuan should hardly be considered a disruptive factor in that regard.